What Founders Should Settle Before Signing a Shareholders’ Agreement

Most founders sign their first shareholders’ agreement at a moment of optimism: a new company, a new partner or a first investor. It is understandable that the document receives less attention than the product or the round. It is also the document that will decide what happens when things go differently from the plan.

A good agreement is not a list of everything that could go wrong. It is a short set of answers to the questions that will, at some point, be asked: who decides, what happens when we disagree, what happens when someone leaves, and how anyone can sell. What follows are the points we ask founders to think about before they sit down with investors or with each other.

Decision-making and deadlock

Two founders with equal shareholdings can build a company quickly. They can also bring it to a standstill if they disagree on something fundamental. The agreement should set out which decisions are for the board, which need shareholder approval, which need unanimity, and what happens if the required approval cannot be obtained.

Deadlock mechanisms range from the gentle to the drastic. At one end, a disputed matter is escalated to a meeting of the shareholders themselves, then to mediation. At the other, one shareholder may trigger a process under which one side must buy the other out. The drastic mechanisms are effective precisely because no one wants to use them, but they can favour whichever founder has better access to money. The right choice depends on the founders, not on a template.

When a founder leaves

Vesting and leaver provisions are often presented as investor protections. In practice they mostly protect the founders who remain. Without them, a co-founder who leaves in the first year may keep the same shareholding as one who stays for a decade, and the company carries a large passive shareholder for the rest of its life.

The usual approach is for a founder’s shares to vest over time, and for a departing founder to be required to offer unvested shares back at a nominal price. The harder question is the treatment of vested shares, which typically turns on whether the founder is a “good leaver” or a “bad leaver”. These definitions deserve care. Illness and death should not be treated in the same way as resignation to join a competitor, and the price at which shares change hands in each case should be agreed now, not argued about later.

Transfers and exits

Most agreements restrict a shareholder’s ability to sell shares to an outsider, usually by requiring that they are first offered to the existing shareholders. Two further provisions often matter more than founders expect. A tag-along right allows minority shareholders to join a sale on the same terms when a majority sells. A drag-along right allows a sufficient majority to require everyone to sell when a buyer wants the whole company.

Each protects a different group, and the thresholds that trigger them should be considered alongside the likely shape of a future exit. A drag-along threshold set too high may make a sale impossible; set too low, it may let a coalition of investors sell the company over the founders’ objections.

Reserved matters and information

Investors will usually ask for a veto over certain decisions. These reserved matters should be proportionate and should reflect how the business actually runs. A list that requires investor approval for routine hiring or ordinary contracts can slow a company down at exactly the stage it needs to move quickly. A list that leaves out the issue of new shares, a change of business or a sale of key assets leaves investors exposed, and they will notice.

The same applies to information rights. Monthly management accounts and an annual budget are reasonable requests. A reporting schedule designed for a finance team of twenty, imposed on a company with one part-time bookkeeper, becomes a source of friction and, eventually, of technical breach.

Funding and dilution

The agreement should say how the company will raise money in future. Pre-emption rights on new issues let existing shareholders maintain their percentage if they wish to invest. Investors may also ask for protection if shares are later issued at a lower price. Founders should model what these provisions would mean in a difficult round, because that is the only time they matter.

The agreement and the constitution

A Malaysian company may adopt a constitution under the Companies Act 2016, and many do. The constitution binds the company and its members; a shareholders’ agreement binds the parties who sign it. Where the two say different things — on share transfers or board appointments, for example — the result can be uncertainty at precisely the moment certainty is needed. The two documents should be prepared together and kept consistent as the company grows.

A shareholders’ agreement need not be long. It does need to be right for the company that signs it, and it needs to be read, by everyone, before it is signed.